Locked into the bailout state

Here is a brief excerpt from a fascinating work of comparative history, highlighting the similarities between 1929 and 2009. History repeats, but this hurts too much to be farce.

Published at the always-interesting TomDispatch, I recommend reading it in full. This excerpt discusses the bleak alternatives offered to us by our ruling elites — Bush’s outgoing red team and the new blue team (or is it vice versa? who can tell the players without a program?)

Sometimes it’s the small gesture that defines the end of an age. Richard Fuld, CEO of Lehman Brothers, the single financial firm the Bush administration allowed to collapse into bankruptcy in what may someday be thought of as the slow-motion Crash of ’09, made one of those gestures recently. Just to be clear, we’re talking about a man who, between 1993 and 2007, took home a tidy $466 million in pay. (That’s no misprint, though it’s a pay level that it would take factories of workers cumulative lifetimes to reach.)

Then, in 2008, the year his firm would collapse, Fuld was awarded another $22 million in what was called “retirement pay.”

Fuld and the other CEOs, who lived fabulous lives in their many mansions and passed out money as if it were sand, have been slow to grasp changing times. After all, as late as last December, according to the Wall Street Journal, John Thain, CEO of Merrill Lynch, “let it be known” that he expected a $10 million bonus in a year in which the company he oversaw had a nifty $28 billion in losses. Like Fuld, these men have proven remarkably tin-eared as well as lead-fingered and, in a season of catastrophe for their firms and for so many Americans, they still managed to pass out a staggering $18.4 billion in bonuses.

It helps, of course, to have a memory. I mean a real memory, a deep sense of what happened once upon a time. Steve Fraser, TomDispatch regular and expert on American Gilded Ages, who has written Wall Street: America’s Dream Palace, a superb history of our country’s kaleidoscopic range of attitudes toward Wall Street, knows that this country went through such a moment with just such a set of tin-eared former titans once before. And while the two moments, 1929 and 2009, differ in striking ways, it’s instructive to know how it all fell out for the Richard Fulds of another age.

Excerpt

Obtuse hardly does justice to the social stupidity of our late, unlamented financial overlords. John Thain of Merrill Lynch and Richard Fuld of Lehman Brothers, along with an astonishing number of their fraternity brothers, continue to behave like so many intoxicated toreadors waving their capes at an enraged bull, oblivious even when gored.

Their greed and self-indulgence in the face of an economic cataclysm for which they bear heavy responsibility is, unsurprisingly, inciting anger and contempt, as daily news headlines indicate. It is undermining the last shreds of their once exalted social status — and, in that regard, they are evidently fated to relive the experience of their predecessors, those Wall Street “lords of creation” who came crashing to Earth during the last Great Depression.

Ever since the bail-out state went into hyper-drive, popular anger has been simmering. In fact, even before the meltdown gained real traction, a sign at a mass protest outside the New York Stock Exchange advised those inside: “Jump, You Fuckers.”

… Nothing, however, may be more galling than the rationale regularly offered for so much of this self-indulgence. Asked about why he had given out $4 billion in bonuses to his Merrill Lynch staff in a quarter in which the company had lost a staggering $15 billion dollars, ex-CEO John Thain typically responded: “If you don’t pay your best people, you will destroy your franchise. Those best people can get jobs other places, they will leave.” …

Locked into the Bailout State

After 1929, when the old order went down in flames, when it commanded no more credibility and legitimacy than a confidence game, there was an urgent cry to regulate both the malefactors and their rogue system. Indeed, new financial regulation was at the top of, and made up a hefty part of, Roosevelt’s New Deal agenda during its first year. That included the Bank Holiday, the creation of the Federal Deposit Insurance Corporation, the passing of the Glass-Steagall Act, which separated commercial from investment banking (their prior cohabitation had been a prime incubator of financial hanky-panky during the Jazz Age of the previous decade), and the first Securities Act to monitor the stock exchange.

One might have anticipated an even more robust response today, given the damage done not only to our domestic economy, but to the global one upon which any American economic recovery will rely to a very considerable degree. At the moment, however, financial regulation or re-regulation — given the last 30 years of Washington’s fiercely deregulatory policies — seems to have a surprisingly low profile in the new administration’s stated plans. Capping bonuses, pay scales, and stock options for the financial upper crust is all well and good and should happen promptly, but serious regulation and reform of the financial system must strike much deeper than that.

Instead, the new administration is evidently locked into the bail-out state invented by its predecessors, the latest version of which, the creation of a government “bad bank” (whether called that or not) to buy up toxic securities from the private sector, commands increasing attention. A “bad bank” seems a strikingly lose-lose proposition:

either we, the tax-paying public, buy or guarantee these securities at something approaching their grossly inflated, largely fictitious value, in which case we will be supporting this second gilded age’s financial malfeasance for who knows how long, or

the government’s “bad bank” buys these shoddy assets at something close to their real value in which case major banks will remain in lock-down mode, if they survive at all.

Worse yet, the administration’s latest “bad bank” plan does not even compel rescued institutions to begin lending to anybody, which presumably is the whole point of this new financial welfare system.

Why this timidity and narrowness of vision, which seems less like reform than capitulation? Perhaps it comes, in part, from the extraordinary economic and political throw-weight of the FIRE (finance, insurance, and real estate) sector of our national economy. It has, after all, grown geometrically for decades and is now a vital part of the economy in a way that would have been inconceivable back when the U.S. was a real industrial powerhouse.

Naturally, FIRE’s political influence expanded accordingly, as politicians doing its bidding dismantled the regulatory apparatus installed by the New Deal. Even today, even in ruins, many in that world no doubt hope to keep things more or less that way; and unfortunately, spokesmen for that view — or at least people who used to champion that approach during the Clinton years, including Larry Summers and Robert Rubin (who “earned” more than a $115 million dollars at Citigroup from 1999 to 2008), occupy enormously influential positions in, or as informal advisors to, the new Obama administration.

… Progressive-minded people in and outside of government must find a way to make re-regulation urgent business, and to do so outside the imprisoning, politically self-defeating confines of the bail-out state. Just weeks ago, the notion of nationalizing the banks seemed irretrievably un-American. Now, it is part of the conversation, even if, for the moment, Obama’s savants have ruled it out.

24 thoughts on “Locked into the bailout state”

I’m ALL in favor of “financial imcompetance” excess bonus taxes, of up to 90% on all bonuses over the last 10 years over 100* last year’s median taxpayer reported income (around $40k? so over $4 mil.), starting at 10% on bonuses over $400k (10* median; also about 1 US President’s salary).

I think such usual clawback taxes should be part of all bankruptcy AND bailouts.

Only when their own assets are on the line will the managers be adequately risk-averse about getting bailout cash or going bankrupt.

I also think bonuses should be more vested over a 4-5 year period.

Pay caps for bailed out firms are also fine –Becker and Posner (against them) notwithstanding.

It’s the Dr. Evil business plan. AIG built the financial Death Star, and they demand one hundred billion dollars — oh, wait, sorry, we’ve already given them one hundred and fifty billion dollars, so it’s they demand hundreds of billions of dollars. If we don’t pay them more money, all these companies depending on AIG go insolvent. These days companies, CITI, BAC, AIG are only valued based on their ability to destroy the world’s economy and extract bailouts, err, ransom, from the US Government.

Obama doesn’t do anything different, because about ten Dr. Evils still have all the missiles pointed at the world’s economy.

Actually that’s not really fair to Dr. Evil, because at least he had the option to not destroy the world. It’s more like we’ve created 10 financial Chernobyls and we have to keep pouring money into them or they explode. Maybe that’s a better metaphor.

In 87, I went to the bank for a working capital loan for our start-up making machinery to filter water. “No”, they said, “but with your education, if you want to build a strip mall, even though you know nothing about it, we’d be happy to lend you the money”. This was the S&L disaster
In 97, I went to the bank for a working capital loan for our business building machinery to filter water. “No”, they said, “but if you want to float a public company making internet or telecoms stuff, we can introduce you to a lawyer who can help you”. This was the Dot-com disaster
In 07, I went to the bank for a working capital loan for our business making machinery to filter water. “No, they said, “but if you want to build tract homes in Modesto, we will lend you the money.” This was the sub-prime disaster.
Don’t get me started on venture capitalists, they’re much worse.
This won’t be over until smart guys out of school who want to start long horizon projects like machine manufacturing can get loans at fair terms. Still not the case…not now,not yet.

Now that the crime has occurred, the real question is how to – er – “reacquire” the hundreds of millions looted by Fuld and his like. If the figures are accurate (above), Fuld got nearly $500 million over the last two decades. We wouldn’t want the poor fellow to starve, now would we? Let’s leave him enough to live on so he won’t have to miss his dinner at the country club or his golf game, and those expensive vacations. A tidy $20 million ought to do it, though quite honestly someone of his morals should be on a chain gang somewhere, not running around free and as rich as they come. However, he got the money legally if not morally, so we’ll leave him some. That leaves a good $450 million left to reclaim. Anyone know someone who can hack into his electonic accounts in the Caymans, or Switzerland, or wherever they might be?

And folks wonder why there are bumper stickers saying “Eat the Rich”? But I jest…. sort of.

Fuld and his kind are bright enough to game the system and make out like Rockefeller on steroids. However, if they have a weakness, it is the hurbis that they are indispensible, that they cannot and will not be held acountable if they push too far. Well, Fuld and Co. better study their history. Lamposts have other uses besides suporting lights….
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.Fabius Maximus replies: I don’t know what the point of this is. Looks like advocacy of tearing up the Consitution and our laws so you can feel better. Don’t worry that you cannot find leaders for such things. While they satisfy your desire for vengence they will fit you for a saddle and bridle. Make sure you enjoy the trade.

Unchecked greed in the Patrician class was the principal reason for the fall of the Roman Republic.
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.Fabius Maximus replies: That’s one theory. Another is that the Roman people found the burden of self-government too heavy. History shows that someone always volunteers to “help” carry that load.

… Getting to Thain and so called bonuses: they are paid at year end only so if Thain had cut his producers loose it would have been without a dime in their pockets. You can bet every former Merrill broker loves him for sticking by them, for being honest. But deeper yet is the method for paying clerical help: they are paid a small salary but get huge compensation in direct payment from brokers, so the bonus money went to the “grunts” and was an out of pocket expense for brokers. Had they not received their “bonus” monies the lower paid help would have been stiffed.

Re # 5 “Now that the crime has occurred, the real question is how to – er – “reacquire” the hundreds of millions looted by Fuld and his like.”
That’s chump change compared to the $2 trillion and more being looted from us by the feds. Feh.

Excellent article by Mr. Fraser. The most important quote from the piece, IMO:

“Why this timidity and narrowness of vision, which seems less like reform than capitulation? Perhaps it comes, in part, from the extraordinary economic and political throw-weight of the FIRE (finance, insurance, and real estate) sector of our national economy. It has, after all, grown geometrically for decades and is now a vital part of the economy in a way that would have been inconceivable back when the U.S. was a real industrial powerhouse.

Naturally, FIRE’s political influence expanded accordingly, as politicians doing its bidding dismantled the regulatory apparatus installed by the New Deal.”

F.I.R.E is burning down the house. Obama’s fireman (Geithner, Summers, Bernanke) only know one way to extinguish the blaze; smother the embers with money. It won’t work.

Hopefully at some point before its too late, they will realize that fires are a requirement of nature, the old dead brush must be cleared out before new growth can emerge.
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.Fabius Maximus replies: While interesting and important, this is all so yesterday. This financial crises is like a hurricane. It has traveled two years through the virtual world of the financial markets, causing great damage. In October it made landfall, and is now traveling along Main Street — wrecking the real economy. This will shortly drive all the nonsense about the banks to page 3, with important news about the real economy on page 1 (page 2 will be about unrest abroad; the EU just decided to let Eastern Europe burn).

The significance of the alphabet soup of government programs in 2008 is solely that they did not resolve these problems when they had the opportunity. Esp shutting down the OTC derivatives books. The effect of these errors will soon become apparent.

I have a sticker “Hey Dude! Where’s MY Bailout” based on this template. Copy it or – better yet – devise your own sticker. We could have s sticker contest, awarding as a prise to the best sticker a dart board with – say – Bernake’s face on it.
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.FM replies: Better yet, Greenspan. Bernanke has not handled the treatment well (very difficult given the politics), but Greenspan was perhaps the individual most responsible for the problem. No child should be named “Alan” for several generations.

Arms Merchant in comment #5: “$2 trillion and more being looted from us by the feds”

Or rather, being looted from the buyers of Treasury Bonds that will never be repaid, and from the owners of debt that will be inflated away.

Quite honestly, if you are not one of those people, why worry about the Feds taking trillions from overseas suckers … err … “investors”, and running the printing presses night and day? Americans get first dibs on these dollars, and the rest of the world only gets them once inflation has taken its bite.

FM:”…Esp shutting down the OTC derivatives books. The effect of these errors will soon become apparent.”

Err, we know the effect is ‘bad.’ Does anyone really know how deep of a hole AIG really is? They were betting against exactly what is happening now, as Krugman recently pointed out. Someone posted a link for me to a story in 2008 where AIG was bragging about $2T in derivatives. I saw another number that AIG had about $300B having wound down from $450B.

Krugman:”But this means that US taxpayers have now assumed the downside risks for all of AIG’s counterparties.”

This is a little conspiratorial, but I wonder if the Austrian banks are hedged against losses in Eastern Europe. Hmm…
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.Fabius Maximus replies: (1) To know the directionality (“bad”) is not the same as knowing the effect. Magnitudes matter.

(2) We do know the answer, and its “no”. It is not possible to hedge such large amounts. Also, who has the money to take the other side of the hedge? I doubt God writes credit default swaps.

Re #11, Right now the issue is deflation, but you ain’t seen nothin’ yet.

The impact of the government weaseling out of its obligations by screwing creditors and inflating the currency (which the stock market seems to be already anticipating) will be yet more injury to business activity. Who will have confidence in the dollar after this debacle? Government, while not exactly producing “nothing” (think research subsidies) produces goods and services at nowhere near the efficiency of the private sector.

The idea that our benighted leaders in the Imperial City can just print and spend wildly without consequences is ludicrous.

FM comments to the effect that events on ‘ Main Street ‘ will soon make the financial industry 3rd page news .
Yep. So where , please , can I find serious analysis and prediction for ‘ Main Street ‘ ?
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.Fabius Maximus replies: You ask too much. A hurricane is traveling down main street, and you ask which buildings will be damaged. Reliably predicting the specific effect of a such shocks — which occur once in 50+ years, during which time the world greatly changes — is beyond human capability.

I have far more specific analysis, but cannot post it here for various technical reasons. But these posts should provide sufficient information to assess the magnitude of the change. That is, assumign my guesses are correct.

Re: # 11 & # 13:
This is outside the general realm of this thread but I must comment.
Inflation does NOT I repeat NOT necessarily impose disaster on business. It depends on the relative predictability of the inflation and it’s relationship to cost and profit. I won’t give a lesson here but suffice to say one should consider these differences: A construction company who must bid 2 years in advance, a grocerer who sells and prices on a 1 week cycle, and a high end retailer who can price essentially on expected value.
In each case the relationship of predictability/net inflation is important.
I could also tie this equation to indebtedness, expectations of corporate profitability, future valuations, GDP, etc.
We also have historic concepts to consider:
The end of the Gr. Dpr. saw deflation of about 2+%
The first 2 years of WW2 saw avg. inflation of about 5%, behaviorally a 7% INCREASE in inflation. A period that got us out of the GDpr.
The period after WW2 between the last annual deflation and the next annual low inflation(less than 2%) was a period of 9 years and had average annual inflation of 6%+. these years are considered the “golden years” of U.S. global ascension.
I could go on but it is sufficient to say in our current economic situation the progression of conditions to hope for in order of preference from best to worst is: 4%-7% inflation, stagnation, 7%-15% inflation, ANY deflation, rampant inflation, rampant deflation.
Pick your poison and choose wisely because a minor error in judgement yields grave results.

A special place in hell belongs to Greenspan and his low interest rate, asset inflation economy based on using debt to leverage ROI.

“Let’s try to place the various huge and increasingly numbing deficit/loss numbers (attendant with this bust) into coherent context. For such an endeavor it is imperative first to examine the preceding boom. This week, in particular, seems an appropriate time to summarize, in credit terms, the incredible dimensions of the fateful inflationary bubble.

From the Federal Reserve’s “flow of funds” report, we can see that total system credit (non-financial and financial) ended 1995 at $18.475 trillion. By the end of 2007, this number had inflated to $49.882 trillion, for growth of 170% in only 12 years. During this period, household debt swelled 184% to $8.959 trillion; non-farm corporate debt 130% to $3.832 trillion; and state and local government borrowings 109% to $2.192 trillion. Federal debt expanded “only” 41% to $5.122 trillion. Rest-of-world holdings of US assets inflated 365% to $16.048 trillion. While significantly trailing credit growth, gross domestic product nonetheless bulged 87% during this period.”

FM:”(2) We do know the answer, and its “no”. It is not possible to hedge such large amounts. Also, who has the money to take the other side of the hedge? I doubt God writes credit default swaps.”

Well, there were bets on the Iceland default, I discovered looking at old news. Nobody has the money pay off these bets, but that apparently never stopped AIG from selling insurance to be paid back with reserves they don’t have — with the American taxpayer now on the hook. A congressman is trying to discover the counterparties, Krugman referred to this in a recent article.
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.FM reply: While interesting to say “there were bets”, that is irrelevant to my point. It is possible to hedge large exposures, but only to the extent that counterparties can be found to take the other side.

I sense that people on this site who have never considered nationalization (or, horrors, socialism!) as anything other than traitorous insanity, are now thinking the Common Good might be a better standard to apply to economic behavior than untrammeled private profit. Egad!

Sorry FM ,to come back to Main Street but it seems to me that all these print inches and government actions are , ” fighting the last war “. The occupation say they must spend ,borrow , normal life will be resumed in September . Borrow , spend , advertise ! Their contractors are eager to lend ! ( but want as security , the natives’ property and land . ) The massive native resistance is convinced it must get out of debt , retreat into secure citadels , go underground . The occupiers need to understand the native culture ; the natives need to know where the heck they can find citadels .
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.Fabius Maximus replies: I have no idea what all this fancy talk means. If unemployment doubles from here (to the levels of the 1973-75 or 1980-82 recession) — or beyond — I suspect we will hear no more of this nonsense. The rich will worry about their homes being burned to the ground by angry mobs, not getting even bigger tax breaks. Jobs programs — putting people to work — and benefits (extended unemployment insurance, expanded food stamps and medicaid eligability) will zip though Congress at warp speed. If necessary over Rush L’s body (metaphoricaly speaking).

I would like to see discussion on ” If ( x ) happens , gov plans to do ( y ) . Here is the costing breakdown . ” This sort of information would help businesses adapt.
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.Fabius Maximus replies: Would you like a pony, also? There is no history of successful treatment of debt deflation — or even of deflation — in developed nations. We are off the map of economic theory and past experience. Betweent he uncertainties of economic theory, financial constraints, and practical politics, the Obama team is moving throught the fog and shadows without a map. Don’t expect more than flesh and blood can provide.

Funny you should mention pony a I do have herd of layabout ponies , and was costing up ideas on back of envelope for a nice little hansom-cab hire enterprise if things went stone age ….but tonight I read UK gov is starting printing money . Or rather it is not printing but making invisible pretend money . If I can pay my tax bill in invisible pretend money my existing business will do just fine .
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.Fabius Maximus replies: The reference is to one of the best webposts ever — “If Wishes Were Horses, Beggars Would Ride — A Pony!“, John & Belle Have a Blog, 6 March 2004.

The whole “printing money” schtict is too bizarre to discuss. I suggest first reading the Wikipedia pages (or sections in a basic economics textbook) about monetary theory. The money the UK is printing today is no more “invisible pretend money” than the money they printed last year, or 20 years ago. All that matters is the supply of “money” (in its various forms) vs. the demand for those various kinds of money. One way to see the deflation grippign the developed nations is as a desire for cash greater than its supply. Hence printing money to stabilize the economy.

FM:”There is no history of successful treatment of debt deflation”, but Japan, post their 1989 Tokyo real estate bubble pop, DOES have a history of treatment. Obama-like fiscal porkulus spending, which as you imply, was not successful.

A Tax Holiday (no Federal collection of taxes) until the recession/ depression ends, thru private consumption and investment, is the cheapest, fastest way out of recession. A truth I believe but cannot prove; and yet a clearly more efficient form of Keynesian deficit spending against a recession (private spending more efficient than gov’t spending, altho there are some value-added gov’t programs for infrastructure).
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.Fabius Maximus replies: Please at least make a pretence of reading the text.

* I did not say that “low real estate prices”, I said “debt deflation”. Citing Tokyo RE prices as an economic indicator is bizarre at best, typical of the RE fetish of this generation of Americans.

* I did not say “history of treatment.” I said “history of successful treatment.” Japan has fought debt deflation for 20 years, and is going down again. GDP decline now at depressionary levels. I cannot imagine how you consider this a success. Esp as to maintain the status quo they have run their government debt up to 180% of GDP, well into “doomed” territory (compared to which Italy looks likes Switzerland).